Private Finance Initiative - Treasury Contents

Written evidence submitted by Professor Ron Hodges[58]


1.  This memorandum is submitted in response to the Treasury Committee's call for evidence for its inquiry into the future of the Private Finance Initiative (PFI). The call seeks evidence on the following points:

—  What are the strengths and weaknesses of different public procurement methods?

—  If PFI debt had been on-balance sheet rather than off-balance sheet would PFI projects have been used as much? How should PFI deals be accounted for?

—  How far can risk really be transferred from the public to the private sector?

—  Are there particular kinds of risk which are particularly appropriate for transfer through PFI deals, or particular projects which are suited for PFI?

—  What state guarantees are explicit or implicit in PFI deals?

—  In what circumstances are PFI deals suitable for delivery of services?

2.  My comments refer specifically to PFI schemes except in cases where wider forms of co-operation between the public and private sectors are included which I will refer to under the generic title as Public Private Partnerships (PPP).


3.  The accounting treatment of PFI under UK-based accounting rules has been inconsistent, between the public and private sectors and within the public sector. The accounting treatment under international accounting regulation may not prove to be adequate in view of the limited scope of application of IFRIC12/ED43. It may be necessary to develop UK additional guidance to support the accounting for new forms of PPP.

4.  There are always implicit state guarantees in PFI/PPP arrangements; these typically relate to service continuity risks which cannot be transferred from public sector responsibility. Other forms of guarantees should be limited in the extreme. Such guarantees should be assessed at Treasury level. The total value of any such guarantees should be placed in the public-domain by the Treasury.

5.  It should be recognised that PFI encourages a "capital asset based" view of public service provision, which may not always be appropriate; that transfer of PFI principles to new parts of the public sector is likely to be time-consuming and expensive; and that a real choice of funding mechanisms is needed to ensure that PFI is not the "only game in town".


6.  The accounting treatment for PFI projects has long been a matter of debate and controversy. For example, there is evidence that, in the early years of establishing the PFI from 1992 to 1997 and prior to the development of formal accounting guidance, there was little in the way of disclosure of PFI contract arrangements and development costs in the accounts of public sector entities.[59]

7.  The development of guidance by the Accounting Standards Board, through its application note[60] (FRS5A) and the revised technical note 1 of the Treasury Taskforce[61] (TN1R) might have been expected to promote consistent accounting treatment of PFI deals in the accounts of both public and private sector entities. This does not appear to have been the outcome.[62] One reason was that, in the public sector, FRS5A and TNIR became de-facto alternative accounting standards, despite the technical note being promoted as an interpretation of the application note. A second reason is that the public sector purchasers and private sectors operators adopted different accounting treatments or interpreted their own risk positions differently, leading to the PFI assets and financial obligations of some schemes failing to be recorded in either set of their accounts. Finally, private sector operators moved towards treating the PFI schemes as debtors, or financial assets, as this typically benefitted them with regards to the profile of profit recognition and tax effects.[63]

8.  There is little doubt that one attraction of PFI deals for public sector purchasers was its ability to provide an "off-balance sheet" accounting approach in which neither the PFI assets nor the related financial obligations appeared on public sector entity balance sheets. This reduced the financial transparency inherent in these deals. It seems that the accounting treatment was influenced by the particular regulations surrounding the funding mechanisms in each part of the public sector; for example local government PFI schemes were invariably off-balance sheet in order to benefit from PFI credit funding arrangements, while central government PFI schemes were more likely to be on balance sheet.[64]

9.  In the immediate future, the accounting treatment of PFI schemes will be based upon the guidance issued by the International Accounting Standards Board in its interpretation statement[65] (IFRIC12) and influenced by the 'mirror' treatment for public sector entities proposed by the IPSASB[66] (ED43). This still leaves open the opportunity for inappropriate off-balance sheet accounting because of the limited scope of arrangements covered by IFRIC12/ED43. In periods of austerity off-balance accounting may be particularly attractive to governments as a means of accessing finance without having to record the underlying obligations. The existence of weak tests for national accounting treatment under ESA2008, also seem likely to allow an off-balance-sheet treatment for many Public Private Partnership arrangements.[67]

10.  I believe that the scope of current PPP accounting proposals in IFRIC12/ED43 will not prove adequate to prevent off-balance sheet accounting for the increasing diversity of PPP structures. It may be necessary for further accounting guidance to be developed in the U.K. to seek to ensure that there is appropriate accounting for PPP/PFI schemes and for the inherent obligations arising from those projects in which significant financial and service continuation risks remain with the public sector.


11.  It is possible and usual for many risks to be transferred to the private sector under PFI schemes. Such transfers are appropriate where the risks are best able to be managed by the private sector. Such transfers may be effective where the private sector truly takes on those risks, will suffer if those risks materialise negatively and will benefit if such risks result in positive outcomes.

12.  It would be expected that risks relating to the construction and maintenance of assets could be transferred in this way. However, it is not apparent that other types of risk have routinely and successfully been transferred from the public sector. For example, it is doubtful in PFI deals is that the risk of service failure can be transferred from the public sector; the taxpayer always picks up the pieces when the private sector cannot deliver and the service has to be maintained.

13.  There are always implicit state guarantees in PFI/PPP arrangements. These relate to business continuity as described above; when the services must be and are maintained irrespective of the performance of the private sector. The terms of PFI deals should reflect this underlying reality. I consider the use of explicit guarantees above and beyond these business continuity risks to be inappropriate to PFI/PPP arrangements unless the terms of such arrangements are also explicit about the financial saving to the taxpayer as a result of such guarantees. For example, how can the private sector be said to have taken on significant financial risk in deals which have involved the public sector providing guarantees for the repayment of borrowing? The early promises that PFI deals would see significant risks taken away from the taxpayer ring very hollow when we find that project failure results in the taxpayer covering private sector losses such as in the Metronet scandal.[68]

14.  The imposition of state guarantees is a particular risk in periods of reduced public spending. The danger is that private sector finance is used to procure public investment and avoid the direct scoring against public expenditure, while at the same time, building up significant obligations that may crystallise in the future. Such 'hidden' obligations should be discouraged in the extreme. This might be done by requiring that any such guarantees are subjected to specific approval after a value for money test at the Treasury level and that public domain data on signed PPP deals provided by the Treasury should also include the total value of guarantees given to the private sector.


15.  Successive governments have promoted PFI deals as being appropriate for service delivery in almost any part of the public sector. I am not aware of there being any robust assessment of the application of PFI across sectors, unencumbered by either financial or public policy interests. However a number of generalisations can be made.

16.  First, the operation of PFI appears to rest upon the need for projects to be based upon significant capital assets such as roads, railways, hospitals and defence systems. It should be recognised that this pushes public policy towards a 'capital asset' solution to a particular problem and it should always be questioned as whether or not this is appropriate.

17.  Second, previous governments have underestimated the difficulties of transferring PFI to new sectors. There seems to have been an assumption that PFI is always a potential, and even a likely, solution and that its principles can easily be transferred across sectors. The reality is often different. For example in the social housing sector, it appears to have been assumed that PFI was equally adaptable to renovation of existing individual properties as it had been to large new-build schemes. There was extensive delay is signing up the first wave of PFI social housing schemes[69] and subsequent lack of evidence of value for money.[70] It needs to be recognised that attempts to extend PFI into new areas will be likely to be accompanied by delay and additional costs above and beyond its application in existing areas of expertise.

18.  Third, the Treasury has consistently promoted PFI on a value for money basis. However, it has often been reported that managers involved in developing PFI schemes have seen it as "the only game in town". In other words, PFI was seen as the only likely route to obtain funding to promote service improvement. Whether this perception was accurate or not, its result was to promote a view that managers needed to support the PFI route if a project was to be completed. This was certainly the impression that I received from work in the health and housing sectors. If PFI is to continue, it needs to be assessed against other types of funding mechanisms on as neutral a basis as possible. This implies that Departments must be given the flexibility to draw on different funding mechanisms as appropriate to obtain best value for particular projects rather than treating PFI financing as a separate (and perhaps the only) pot of money available for a range of projects. Such flexibility should be assured without the need to provide state guarantees or other forms of subsidy which has brought PFI into disrepute in the past.

April 2011

58   I am Professor of Public Services Accounting at the University of Sheffield Management School. I take sole responsibility for the contents of this memorandum and the views expressed here should not be attributed to any organisation with which I am or have been connected or to any person who may have worked or co-authored papers with me. Back

59   Hodges, R and Mellett, H (1999), 'Accounting for the Private Finance Initiative in the National Health Service', Financial Accountability & Management, vol 15, no 3&4, pp 275-90. Back

60   Accounting Standards Board (1998), Amendment to FRS5 Reporting the Substance of Transactions: Private Finance Initiative and Similar Contracts, London: ASB. Back

61   Treasury Taskforce (1999), Technical Note 1 (revised): How to Account for PFI Transactions, London: H.M. Treasury. Back

62   See for example, Financial Reporting Advisory Board (2006), "'On-On' and 'Off-Off' balance sheet PFI/PPP Capital Assets-Issues and Recommendations-Office for National Statistics", Agenda Item 82(04) of the FRAB meeting-31 October 2006, London: FRAB. Back

63   Heald, D and Georgiou, G (2011), "The Substance of Accounting for Public Private Partnerships", Financial Accountability & Management, vol 27, no 2, pp 217-47. Back

64   See the table of signed PFI deals on the Treasury web-site, which is summarised in Heald and Georgiou (2011, p 225). Back

65   International Accounting Standards Board (2006), IFRIC12 Service Concession Arrangements, London: IASCF Publications. Back

66   International Public Sector Accounting Standards Board (2010), Exposure Draft 43: Proposed International Public Sector Accounting Standard-Service Concession Arrangements: Grantor, Toronto: IPSASB. Back

67   European PPP Expertise Centre (2010), Eurostat Treatment of Public Private Partnerships: Purposes, Methodology and Recent Trends, Luxembourg: European Investment Bank. Back

68   National Audit Office (2009), Department for Transport: The failure of Metronet, HC 512, Session 2008-09, The Stationery Office, London. Back

69   Hodges, R. and Grubnic, S. (2005), Public Policy Transfer: The case of PFI in Housing, International Journal of Public Policy, vol 1 no 1&2, pp 58-77. Back

70   National Audit Office (2010), PFI in Housing, HC71, Session 2010-11, The Stationery Office, London. Back

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© Parliamentary copyright 2011
Prepared 10 August 2011